NEW YORK (TheStreet) -- Investing in the stock market is no easy game. Many enter with high hopes, only to find themselves crushed and broke after a few months of trading. That is the harsh reality for would-be investors who do not exercise caution, and who do not strive to find knowledge and understanding before they pump their money into the first "hot" share.
There is money to be made in the stock market, but competition is strong and fierce, and experienced traders have been learning the tricks of the trade for a long time. First-time stock market investors often enter this strange world of numbers with false expectations and ideals that ultimately lead them towards common mistakes.
Those who are new to the world of the stock market would do well to learn from these errors before they find themselves astray. Here are nine mistakes that first-time stock market investors frequently make:
1. Not Having A Plan
Successful stock market investors have a solid plan, and they stick to it. Newbie investors on the other hand tend to go in blind, like a boat without a compass, and therefore get lost and stranded at sea.
A personal investment plan helps you to map your goals and objectives, your entry and exit points, the amount of capital you will invest in a certain trade, any potential risks, the maximum amount you are willing to lose, and your plans to diversify your portfolio. With these details you will be able to invest with purpose, according to and against your own principles.
New investors who make a plan may also struggle to stick to it, and change their course whenever the market dips, or whenever an investment doesn't go exactly as they expected. Sticking to your plan will help you to navigate the stock market even when times are tough. Not having one can cause you to flail out and make emotional decisions that are detrimental to your aims.
2. Playing The Guessing Game
Playing the guessing game with your stock market investments is exactly the same as gambling. It is your ability to work with stock market data and other relevant channels of information that distinguishes the two.
A real investment is not made on speculation, or on the basis of a rumor that you heard, but on a valuable opportunity that you have researched, and which looks like it will pay enough long term profits to justify the risk.
New stock market investors tend not to do their homework very well, or at all. You should never take a stab in the dark with the stock market; you may as well play roulette. Instead, try to gather and monitor enough data that you can start to make informed decisions about where you will invest your money.
There are many places to find relevant stock market data and information related to the company who you wish to invest in. A great start is reading the major business newspapers like The Wall Street Journal or the Financial Times. Yahoo! Finance is a great place to find news and information about companies. Web sites like TheStreet, MarketWatch and others cover the markets and stocks, as well. Another place to go is Web sites like INDX.guru, which helps new investors work with stock market data and interpretive monitoring tools, in order to make choices just as well as those with much more experience (disclaimer: I work with INDX.guru).
Do your homework, stick to the plan, and your investments just might pay off.
3. Not Understanding Risk
Every investment comes with a certain amount of risk. That is the nature of the stock market, and of all investments. Newcomers often don't properly evaluate the risk of their investments, or their own tolerance to that risk. This can cause them to make flamboyant moves with serious life savings that quickly land them in the dump.
On the other side of the coin, risk aversion can create a psychology of scared money, in which the first time investor is frightened to take an opportunity that looks lucrative because they don't want to risk the losses.
There is a balance to be found, and it lies in knowing that every investment is a risk, and also in knowing the margins that you are willing to push.
There are safe bets out there; investment options that come with very little risk. One example is to purchase blue-chip stocks from a very well established company. There is always some risk involved, but you can be fairly confident that these stocks will rise, or that the company will pay dividends.
Investments in which you stand to gain more, generally (but not always) come with a higher amount of risk. New investors fail to think about what they stand to lose as well as what they stand to gain. Your risk tolerance will likely determine, at least to some extent, your style of investment.
4. Not Knowing How Much Is Too Much
If you are new to stock market investments, and you play with only money that you are willing to invest, then you at least only stand to lose what you can afford. The single most devastating error that a first time investor can make, is to play with money that they cannot afford to lose. This is a direct ticket to complete emotional turmoil, irrational decision making, and perhaps even financial destruction.
Whatever you do, only play with money that is yours. Do not take out loans to invest in stocks, especially if you are a beginner. Don't invest your own reserves. Even experienced investors keep a liquid asset stream.
5. Short-Term Thinking
Many new investors rush to make their first stock market investments. The stock market isn't some sort of get-rich-quick playground.
New investors often enter with high hopes for a steep and rapid profit, and they want to make it big with short-term investments. This makes for bad investment decisions at the best, and for many leads to nothing but a quick exit from the marketplace.
More established investors have a totally different idea about what makes a short-term and a long-term investment. In their view, a long-term investment might be 20 or more years, and even when they consider an investment to be short-term they will probably be looking to stick with it for three-to-four years.
If you thought you were going to turn a quick profit in a few months then it is time to reframe your approach to time. Be in it for the long run, or don't be in it at all. Investment is best seen as a process of long-term wealth accumulation.
6. Selling Out In A Panic
If you do have a long term plan in place, and you understand that stock market movement is best understood over the course of years and not weeks and months, then you probably won't be in much of a panic if stocks start to decline. Stocks rise and fall all of the time.
First-time investors, if they have a short-term attitude towards investments, or obsessively monitor their stocks for daily movement, can often get more than a mild case of hysteria if they spot a downward trend. This can cause them to sell out their position blindly, without properly considering whether or not they are likely to rise back up.
Very short-term trends are not great indicators overall, and experienced investors may see opportunity for recovery. Whatever happens you shouldn't panic. Now is the time to make wise, sober-minded decisions.
7. Failing to Cap Losses
The opposite to selling out in a blind panic, but just as damaging when the tides are against you, is to hold on to a losing stock even when market indicators suggest that the share is unlikely to pick up again. Did you see the keyword there? "Market indicators." This is what an experienced investor uses to decide whether a downward trend is just a temporary blip, or whether it is a long-term loser.
Experienced investors cap their losses, and move onto the next investment idea. When a share is depreciating, knowing when to cut your losses is essential.
8. Failing to Diversify Investments
This really is a huge mistake that a lot of first time investors tend to make. It is never clever to put all of your money in one investment, or even one type of investment. Markets can crash, and stocks for a single company can go down the drain. If your whole investment strategy revolves around one company, or even one industry, then a single movement could cause you huge trouble.
More savvy investors tend to diversify their investments across several industries and sectors, and have a portfolio that involves stocks in a variety of different companies.
Investors who feel intimidated with the market can reduce their risk and increase their diversity by investing some of their money in mutual funds and index funds, as well as making their own choices in a diverse way. It is also useful to keep assets outside of the stock market; keep some money separate, and invest in hard assets such as gold to diversify even further.
9. Investing In Alluring Stocks
First-time investors, if they are not making their decisions based on the proper information and stock market data, often do so based on what looks like a good deal. The problem with this is, those which look good at first glance, are not often the most lucrative investment opportunities.
Many new investors think that a low stock price makes for a great opportunity, but this is not necessarily true. Value is key, not price. Sometimes high priced stocks offer a high potential for return, and low priced stocks can be worthless investments.
Following the herd is another mistake, and can lead new investors into paying too much for a "hot" stock that will not hold its value in the long term.
Experienced investors are aware of trends, but do not blindly follow the herd. They seek value in the marketplace, and make solid investments based on data.
The good news is, you can learn from these common mistakes without having to make them yourself. If you are new to the stock market, or are thinking about starting your portfolio, then think carefully about these lessons.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.